India’s interest-rate setters, expected to slow their monetary tightening, may be making the right decision, experiences from the rest of the world show.
Central banks world over eased interest rates to record lows and launched unprecedented liquidity support after the Covid pandemic hit in 2020 but have slammed the brakes over the last several months as they seek to curb red-hot inflation.
Faced by a cost of living crisis triggered by the pandemic-driven fiscal and monetary easing, monetary authorities are leaving no stone unturned to ensure that inflation expectations do not get entrenched, damaging growth over the medium term.
Despite an impending recession and recent financial market volatility, several of these central banks are expected to press ahead with their rate hikes. Many of the same banks tightening today had misdiagnosed the inflation problem and had expected prices to cool off as lockdowns eased.
While the US Federal Reserve’s sharp rate hikes have been the talk of the town, given the outsized impact of US policy on the rest of the globe, several other central banks took the lead in tightening their monetary stance well before the United States.
Take, for example, Chile, where the central bank has raised the policy rate by a whopping 10.75 percentage points since July 2021. Despite this, inflation continues to be four times the South American country’s target, fuelled by the energy cost spike and rising wages.
Or Brazil, where the central bank has hiked the interest rate by 11.75 basis points but retail inflation is still expected to be above target in 2024.
India: Frontloading rate hikes
In India, policymakers moved swiftly and in tandem to curb prices after tolerating above-target inflation for more than two years.
While the central bank kept raising policy rates from early May, the government also slashed taxes on fuel and took a slew of measures, including export curbs, to keep food prices in check.
The Reserve Bank of India has raised the policy repo rate by 190 basis points since early May and is widely expected to raise them again. Policymakers have frontloaded rate hikes, which take three-to-four quarters to have an impact on the economy, with the hope of curbing inflation down the line.
The persistence of India’s retail inflation above the tolerance band of 2 percent to 6 percent for three consecutive quarters ending September will trigger the accountability process.
The central bank will soon submit a report to the government detailing the reasons for its failure to rein in inflation, the remedial actions it plans and the period within which inflation will recede into the tolerance band.
The Reserve Bank is expecting inflation to come down close to the 4 percent target over a two-year cycle, Governor Shaktikanta Das has said.
Only two more rate increases?
Still, from December, the monetary policy committee is expected to revert to 25-basis-point rate increases from the recent 50-basis-point hikes. One basis point is one-hundredth of a percentage point.
Moreover, the repo rate could settle at around 6.5 percent from the current 5.9 percent, according to economists, which means only a couple of more rate increases.
RBI staff said in an article in October that the fight against high inflation would be “dogged and prolonged” considering the lag with which policy operates and the uncertainties involved.
India’s finance ministry, which wants inflation to be managed not just by the central bank but also by the Centre and states, expects inflation to come down in the months ahead.
Eyeing a growth upswing
As such, the central bank projects that inflation will cool to 5 percent in April-June 2023 from 6.7 percent in the current financial year.
If the central bank were to keep hiking rates, the damage to the economy, which is now above the pre-pandemic level but still below the pre-pandemic trajectory, could hurt millions still reeling under financial stress.
As pointed out by rate-setter Jayant Varma, in a slowing world, growth will be driven by domestic demand, which is still not sufficiently robust.
An unreasonably high-interest rate must not thwart the investment cycle and the subsequent growth upswing.